China is the second-largest economy in the world and last year edged out the U.S. as the world's top manufacturer, according to IHS Global Insight. While their economy grows, the country is hoping its currency—the renminbi—will continue to gain ground internationally, potentially at the expense of the United States dollar. As far as the U.S. is concerned, that could be a good thing.
In recent years, China has taken steps to promote the renminbi in its financial markets. The currency is no longer formally tied to the U.S. dollar, and some Chinese companies now use it to perform international transactions. That leaves some to speculate that the renminbi could replace the dollar as the dominant global currency in the foreseeable future. While that may not occur in the short term, a new report from the Brookings Institution notes that given China's size and growth, the steps toward a more open currency may mean that China could have its wish granted, and the renminbi could be more dominant internationally.
The report predicts that the renminbi "will become a competitive reserve currency"—a currency that major countries' central banks hold in reserve—"within the next decade, eroding but not displacing the dollar's dominance,"which could benefit the U.S. economy and hurt China in the process.
Of the six largest countries in the world, China is the only one whose currency is not a reserve currency. Before the Chinese currency can be held on the same scale internationally as even minor reserve currencies, like Japanese yen or Canadian dollars, China would have to take big steps, like making its currency fully convertible.
Currently, that is not the case. The Chinese government holds the renminbi at an artificially low value, making its exports cheaper in other markets and boosting growth. Loosening that grip would slow the growth of the Chinese economy.
"If they ever let [the renminbi] become convertible and let it float, the Chinese economy is going to grow a lot slower and the U.S. economy is going to grow a lot faster. And both of those are against china's wishes," says Peter Morici, professor at the University of Maryland's School of Business.
Being the dominant reserve currency is a dubious honor, says Nicholas Lardy, senior fellow at the Peterson Institute of International Economics, making for bigger trade deficits. The U.S. dollar currently accounts for roughly 60 percent of international reserves. If the Chinese share increases at the expense of the U.S., says Lardy, it could have positive effects for the United States, starting with a weaker dollar. While that may mean more expensive Volkswagens and Toyotas, it could also mean a stronger market for U.S. exports.
"I would say from the point of view of the U.S., we would be better off if the dollar played a smaller role as a reserve currency. If central banks around the world are buying up dollars to hold as their reserves, that means the dollar is going to appreciate. And that is going to mean that we are more likely to run trade deficits, because the dollar is still strong, [and] imports are cheap," adds Lardy.
China's leaders have added fuel to this debate. In 2009, it called for a new global currency to replace the dollar as the world's dominant store of value. In 2011, Chinese President Hu Jintao said that the current international system, in which the dollar is dominant, is "a product of the past."
According to Lardy, Chinese leaders' views on their country's money may have more to do with politics than the costs and benefits of a more-prominent currency.
"It's not clear whether or not they really see this trade-off. I think they're focusing more on prestige and less on this potential slight economic downside."